Redemption in kind is the one liquidity management tool that removes the redemption from the fund's liquidity problem altogether, provided the slice is genuinely pro rata and the rounding does not quietly turn it back into cash.
A redemption in kind gives the redeeming investor its pro rata share of every holding, rounded to each asset's transfer lot, with the rounding residue paid in cash. On an illustrative 250 million credit fund, an investor redeeming 10 per cent, 25.0 million, receives 2.5 million of bonds, 18.5 million of loans and 4.0 million of cash, and the fund it leaves behind is still 14.89 per cent liquid. Paid in cash, the same exit would leave the fund 6.61 per cent liquid and charge the remaining investors the cost of selling.
Worked in full in The AIFMD II Handbook by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
AIFMD II puts redemption in kind on the list of liquidity management tools a manager can select for an open-ended AIF, and expects it, outside narrow exceptions, to be used for professional investors and to be a pro rata share of the fund. That condition is what makes it work: a true slice takes the fund's illiquidity with it, so the investors who stay hold the same mix they held before. The calculation is short; the decisions inside it, rounding and valuation, are where the fairness is won or lost.
| Holding | Carrying value | % of NAV | Transferability |
|---|---|---|---|
| Cash | 15.0 | 6% | Paid out |
| Listed bonds | 25.0 | 10% | Any amount |
| Ten bilateral loans, A to J | 210.0 | 84% | Multiples of 0.5 million |
| NAV | 250.0 | 100% |
There are 1,000,000 units at 250.00 each. A professional investor holding 100,000 units, 10 per cent of the fund, redeems in full: 25.0 million. The lender of record on each loan accepts transfers in multiples of 0.5 million.
In-kind amount per asset = redeeming share × holding, rounded to the transfer lot. Cash adjustment = Σ (pro rata amount − amount transferred).
In Excel, with holdings in B2:B11, the share in E1 and the lot in E2: =FLOOR(B2*$E$1,$E$2) for rounding down, or =MROUND(B2*$E$1,$E$2) for the nearest lot; the cash adjustment is =SUMPRODUCT(B2:B11*$E$1)-SUM(C2:C11).
Step 1: the share. 100,000 ÷ 1,000,000 = 10 per cent. The slice is 10 per cent of everything: 1.5 of cash, 2.5 of bonds and 21.00 of loans.
Step 2: round each loan to its lot.
| Loan | Holding | Pro rata | Rounded down | Nearest lot |
|---|---|---|---|---|
| A | 32.4 | 3.24 | 3.0 | 3.0 |
| B | 28.7 | 2.87 | 2.5 | 3.0 |
| C | 26.0 | 2.60 | 2.5 | 2.5 |
| D | 24.3 | 2.43 | 2.0 | 2.5 |
| E | 22.6 | 2.26 | 2.0 | 2.5 |
| F | 21.5 | 2.15 | 2.0 | 2.0 |
| G | 19.8 | 1.98 | 1.5 | 2.0 |
| H | 15.9 | 1.59 | 1.5 | 1.5 |
| I | 11.2 | 1.12 | 1.0 | 1.0 |
| J | 7.6 | 0.76 | 0.5 | 1.0 |
| Total | 210.0 | 21.00 | 18.5 | 21.0 |
Step 3: the cash adjustment. Rounding down transfers 18.5 of loans against a pro rata 21.00, so 2.5 million is paid in cash on top of the investor's 1.5 share of the cash: 4.0 million of cash in total. Rounding to the nearest lot happens to transfer exactly 21.0, so only the 1.5 of pro rata cash leaves; each line is within 0.24 million of its exact share.
| Method | NAV | Cash | Bonds | Loans | Liquid, % of NAV |
|---|---|---|---|---|---|
| Before the redemption | 250.0 | 15.0 | 25.0 | 210.0 | 16.00 |
| In kind, nearest lot | 225.0 | 13.5 | 22.5 | 189.0 | 16.00 |
| In kind, rounded down | 225.0 | 11.0 | 22.5 | 191.5 | 14.89 |
| Paid in cash | 224.854 | 4.5 | 10.354 | 210.0 | 6.61 |
The cash route keeps a 2 per cent buffer of 4.5 million, takes 10.5 from cash and sells 14.646 million of bonds at a 1 per cent cost to raise the other 14.5. The 0.146 million of cost falls on the investors who stay, about 0.163 euro per remaining unit or 6.5 basis points of NAV. Loans become 93.39 per cent of the fund. If a second investor then asked for 10 per cent, 22.5 million, the fund paid in cash would have 14.9 million of liquid assets to meet it, a cover of 0.66; after the in-kind redemption it has 33.5 million, a cover of 1.49.
Rounding down is a common default because it never transfers more than the investor's share of any loan, but it is not neutral. Here it sends 26 per cent of the slice out as liquid assets against 16 per cent for the fund, so the leaver takes more than its share of the liquidity and the stayers' liquid share drops from 16.00 to 14.89 per cent. With a larger redemption, or coarser lots, the gap widens. Rounding to the nearest lot keeps the total pro rata at the cost of small over- and under-transfers line by line; a third method allocates the residue to loans in order of their rounding remainder until the total is met. Whichever is chosen, it belongs in the redemption policy before the first request, not in the trade ticket.
All figures are illustrative. Whether in-kind redemption is available, to whom, and on what rounding and valuation terms, is set by the fund documents and the applicable rules, and the transfer of each loan by its own terms.
How the book sets the liquidity tools against a semi-liquid credit fund's own stress numbers is in the free workbook for this case; the levy that charges sale costs to the leaver is worked in how an anti-dilution levy is calculated.
AIFMD II lists redemption in kind among the liquidity management tools and, outside narrow exceptions, expects it to be used for professional investors and to correspond to a pro rata share of the fund's assets. The test in the file is that the slice mirrors the fund: here 26 per cent liquid when rounded down against 16 per cent for the fund, a deviation that has to be explained or reduced.
Each loan's pro rata amount is rounded to its minimum transfer lot and the difference is settled in cash. With 0.5 million lots, rounding down on ten loans moves 2.5 million of the 21.00 million loan slice into cash; rounding to the nearest lot moves nothing in total here, with each line within 0.24 million of its exact share. The method should be written in the policy before it is used.
Not if assets go out at the same values used to strike the NAV. A cash redemption does: selling 14.646 million of bonds at a 1 per cent cost to pay a 25.0 million exit costs 0.146 million, about 6.5 basis points of the remaining NAV, unless a levy or swing price charges it to the leaver.
This article is one calculation from The AIFMD II Handbook. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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